I worked in a small-town, old-style drugstore in high school, waiting on customers and keeping track of the drug and chemical inventory in the basement. The poisons had the skull and crossbones on the bottles. Scared the heck out of me.
Those bottles were uncompromisingly honest, and a little fear can help you make better decisions. All investors should treat investing in biotechnology as if it were a bottle with a big ol' skull and crossbones screaming atcha.
We practice what we preach. Our investment last week in Rockville, Maryland-based Human Genome Sciences (Nasdaq: HGSI) contained this warning label on the bottle:
"It has virtually no revenue. The revenue it hopes to generate in the future depends on the approval of its drugs, the protection of its patents, the acceptance of its technology, and other uncertain factors. Even in the best-case scenario, HGS won't see revenue from its first drug for three to five years. It may make money from its data in the meantime, but that is not its business. Thus, significant revenue is years away, and actual profit some years beyond that, since HGS will spend heavily on research during that time."And that's for a company with human trials of real drugs hoping for Food & Drug Administration (FDA) approval in the next few years. But, people out there are buying and selling shares in companies that have less potential than Human Genome Sciences, Celera Genomics (Nasdaq: CRA), or another Rule Breaker portfolio candidate, Millennium Pharmaceuticals (Nasdaq: MLNM). Way less. Those companies' bottles should sport enormous skulls and crossbones, and maybe even a Mr. Yuck.
If you're a longtime Rule Breaker investor, you know this already. If you're dropping by for the first time or so, please check out the Rule Breaker resource links to the right. Hey, it's dangerous out there.
Now that we've taken our -- gulp -- medicine...
OK, you told us that you're very interested in looking at more biotechnology industries: Do any satisfy the first criterion for a Rule Breaking investment -- an important, emerging industry, with a top dog and first mover?
When I was growing up, the question was: Can modern medicine perform successful organ transplants? Today there's a shortage of organs for increasingly successful transplants. This shortage has driven research and development in tissue engineering: replacing diseased or damaged living tissue with living tissue designed and constructed for the needs of each individual.
I borrowed that definition from tissue engineering leaders Joseph Vacanti and Robert Langer, professors at Harvard and MIT, respectively. They are fast friends in a world famed for fierce rivalries and back-stabbing. Their work and graduate students have seeded the field worldwide.
Here's their overview of tissue engineering, published last year in the respected British medical journal The Lancet:
"All procedures that restore missing tissue in patients require some type of replacement structure for the area of defect or injury. This form of therapy accounts for a large part of healthcare resources. These devices have traditionally been totally artificial substitutes (joints), nonliving processed tissue (heart valves), or tissue taken from another site from the patients themselves or from other patients (transplantation). Now a new alternative, tissue engineering, is becoming available to clinicians: the replacement of living tissue with living tissue that is designed and constructed to meet the needs of each individual patient."The size of the engineered organ market
Langer and Vacanti identify the pressing need for human organs, including these among many examples in their article:
- 3 million cardiovascular procedures a year.
- 2.5 million orthopedic and plastic reconstruction (bone, cartilage, tendon, ligament, and breast)
- Estimated cost of diabetes care per year? More than $100 billion.
- tissue engineering company market caps of $3.5 billion
- growth rate of 22.5% per year
- 2,500 employee scientists
- $450 million expenditures
- market potential of $80 billion
Tissue engineering researchers work in three major ways today. They seek to generate:
- organs from animal cells for use in humans ("xenotransplantation")
- organs from human cells in the lab for human use
- organs in humans
- Wound care (diabetic ulcers, burns, etc.) using skin, cartilage, and bone
- More complex organs (livers, hearts, kidneys, breasts)
- Most difficult: Central nervous system (spinal chord injuries, brain)
The liver, heart, kidney, and breast are more complex organs and tougher. Nerves? The biggest challenge. And, like drugs, tissue engineering products require extensive and expensive trials before FDA approval is possible.
Important, emerging industry?
I'm not sure there's any debate that tissue engineering is an important industry. Not only could it do good, but it could have wonderful benefits for people with room for profits and reduced medical costs. (Is there a healthcare economist in the house?)
The tougher question: Is it emerging?
The experts caution us. Vacanti and Langer also wrote in Scientific American: "In the next three decades, medical science will move beyond the practice of transplantation and into the era of fabrication."
Three decades, folks. That's a long time to fund research costs and wait for potential profits -- should they materialize. That doesn't mean these companies will be bad investments, since the market will evaluate them on their future potential rather than current earnings. But, an investor in these companies is taking a big risk that, among other things, the value of discounted future cash flows won't justify today's market price, or that the companies won't even develop a viable product.
You can be sure that good engineered tissue products will make money -- the market is huge. But, the first wound care products, though beneficial, are no wonder drugs (more on this tomorrow). The industry may be emerging, but just barely.
There may be something to learn here by analogy to the technology investing principles of Moore, Johnson, and Kippola's The Gorilla Game for technology stocks. Fools debate this on our Biotech and the Gorilla Game board.
Also, we'll present some useful tools for biotech company analysis in The Motley Fool's first Biotechnology Online Investing Seminar, starting October 16 and open for registration now. Another resource: While I was putting the finishing touches on today and tomorrow's columns, I saw the start of a great tissue engineering thread at ElricSeven's Research Corner. Check it out!
Give it some thought: Do you think tissue engineering is important and emerging? Inquiring Fools want to know on the Rule Breaker Strategies board.
Tomorrow we'll look at whether there's a top dog or first mover among tissue engineering companies. Keep in mind that some tissue engineering companies may be great investments, even if they don't satisfy the Rule Breaker criteria. Hey -- they might be perfect investments for you exactly because they don't! See you then.
--Tom Jacobs, TMF Tom9 on the discussion boards